MI 2022 PU3 Preliminary Examination Paper 1 Answer Guide

1 2022 H2PAA Pu3 Prelim Paper 1 Answer guide Question 1 (a) Categories Transaction Total assets Profit Working capital Equity Increase Decrease Increase Decrease Increase Decrease Increase Decrease (i) 3 340 3 340 3 340 3 340 (ii) 1 000 1 000 1 000 1 000 (iii) 480 20 20 20 (iv) 50 000 50 000 50 000 (b) Computation of profit available for distribution to ordinary shareholders. $ Net profit before interest 100 000 Less: Interest expense (6% X 400 000) 24 000 Net profit 76 000 Less: Preference dividend (8% X 400 000) 32 000 Profit for distribution as ordinary dividends 44 000 (c) Gotham Hot Wheels Gears Debt – Equity Ratio 66.67% 42.86% 0 Total liabilities/ Total Equity 400 000/ 600 000 300 000/700 000 0/1 000 000 Gotham is the most highly geared as it has the highest debt – equity ratio of 66.67%. (d) ▪ Risk of not being able to generate enough profits to cover interest costs which is a mandatory expense and hence make a loss. ▪ Risk of not being able to repay its interest and debt when they fall due which may result in a company being forced into liquidation ▪ Risk of fluctuation in EPS ▪ Risk of not being able to obtain more loan capital (e) In years of high profits, it will be better to be an ordinary shareholder are entitled to share larger profits as there will be more profits available for distribution as ordinary dividends after paying fixed interest expense and preference dividends. For bondholders, the interest received is fixed regardless of the profits earned. (f) Trade unions/Management/Lenders/Suppliers/Government/General Public

2 Question 2 (a) Swee Silk Limited Statement of Cash Flows for the year ended 31 March 2022 Cash flows from operating activities $’000 $’000 Net profit for the year before interest [240 +60] 300 Adjustments for : Depreciation (12.5% X 280 000) 35 Loss on disposal (15 - 20) 5 Operating cash flows before movements in working capital 340 Increase in inventory (170) Increase in trade receivables (110) Increase in trade payables 79 (201) Net cash provided by operating activities 139 Cash flows from investing activities Deposit for PPE (30) Purchase of non-current assets (280) Proceeds from sale of non -current assets 15 Net cash used in investing activities (295) Cash flows from financing activities Proceeds from loan 400 Issue of share 70 Repayment of old loan (10) Repayment of new loan (60) Interest paid (60) Dividends paid (20+20) (40) Net cash provided by financing activities 300 Net decrease in cash and cash equivalents 144 Cash and cash equivalents at beginning of the year (54) Net decrease in cash and cash equivalents 144 Cash and cash equivalents at end of the year 90 (b) Overall, there was a improvement in the company’s cash resources from an overdraft of $54 000 to a positive balance of $90 000. Cash from operations tied up in inventory & receivables. Business made a profit of $300 000 before interest but was only able to generate cash of $139 000 from its operations Business made major investment in PPE totalling $310 000 which resulted in net investment outflow of $295 000.

3 The purchase of PPE was financed by new loans of $400 000 and issue of shares of $70 000. This inflow of cash was used in the repayment of loans ($70 000), interest ($60 000) and dividends ($40 000). ( c ) ▪ Holding excessive inventory leading to cash from operations being tied up in inventory. ▪ Inefficient management of trade receivables resulting to cash from operations being tied up in trade receivables ▪ Inadequate funding for PPE investment of $580 000 (280 000 + 300 000) funded by loans and share issue of $470 000, leaving $110 000 to be funded by its operations. ▪ If profits fall in the future, the business may have problems repaying its loans of about $100 000 per annum. Currently cash from operations come up to $139 000. Question 3 a. $ Beginning equity on 1 July 2021 5 000 000 New OS 2 000 000 Net Profit [320 000 – (5%x 1 000 000)] 270 000 Less Dividends (180 000) Ending equity on 30 June 2022 7 090 000 b. ROE = Net Profit = 270 000 = 4.47% Average Equity (5 000 000 + 7 090 000) / 2 c. Return excess funds to shareholders through higher dividends. Return excess funds to shareholders through share buybacks. // Any 1 relevant point d Earnings per share = Net profit = 270 000 = $0.06 Average no of OS (3 400 000 + 5 400 000)/2 Dividend yield = Dividend per OS = 180000/(3400 000 + 2000000) = 1.67% Market price per OS $2 Price earnings ratio = Market price per OS = $2 = 33.33 times Earnings per OS $0.06

4 e Lilly Limited is a better investment - Lilly has higher, hence better EPS. Each share earns more profit in Lilly than Kenny so there is a chance of higher dividends in Lilly than Johnny. - Lilly has higher, hence better dividend yield. Each share invested now in Lilly earns higher returns than in Johnny. (Kenny should also compare against yield from other investments e.g. savings interest) - Lilly has a higher Price Earnings ratio. Investors are more confident in Lilly than in Johnny and are hence willing to pay a higher price relative to earnings. 6 marks - 2marks per point Question 4 a. Income statement for the year ended 30 June 2022 Revenue $ $ Sales 104 600 Less: Expenses Assistant’s wages 16 000 Make up supplies 21 200 Motor vehicle expenses [(6400 + 2000) x ¾] 6 300 Advertisement (1200+400+600) 2 200 Depn – MV [(100 000 + 16 000) X 20% X ¾] 17 400 Depn – equipment (50000 X 20%) 10 000 Interest (60 000 X 5% X 6/12) 1 500 (74 600) Net profit 30 000 Working: To find as sales: Analysing trade receivables Beginning balance + Sales – Receipts = Ending balance 3500+ Credit Sales – 87 000 = 2 600 Credit sales = 86 100 Total sales = 86 100 + 18 000 + 500 = $104 600 To find make up supplies used: Analysing payables Beginning balance + Credit purchases – Payments = Ending balance 950 + Credit purchases – 21 000 = 1 350 Make up supplies purchased = 21 000 – 950 + 1350 = 21 400 Make up supplies purchased & used = 21 400 – 200 = 21 200 (c)Advantages of keeping a full set of accounts ❑ Detection of errors is easier as a trial balance can be prepared. ❑ Fraudulent entries are difficult to make. ❑ Ensures that important items or transactions are not omitted as there are no or inadequate records of capital, accounts payable, expenses, revenue, etc.

5 ❑ Assurance of accuracy and reliability of information produced for better decision making. ❑ Meets legal requirements. Marie Antoinette Balance sheet as at 30 June 2022 $ Cost Acc Depn Net Book Value Non-current Assets $ $ $ $ Motor vehicles 116 000/ 23 200 92 800 Equipment 50 000 30 000 20 000 Total non-current assets 112 800 Current Assets Loan to employee 5 000 Trade receivables 2 600 Income receivable 500 Bank 115 800 Cash (18 000 – 16 000 – 1 200) 800 Total current assets 124 700 237 500 Equity Capital, at start 57 950 Add: Additional capital (100 000 + 2 000) 102 000 Net profit 30 000 189 950 Less: Drawings (9 800 + 200 + 5 800 + 2 100 ) (17 900) 172 050 Non-current liabilities Loan (100 000-40 000)/5 X 4 48 000 Current liabilities Current portion of long-term borrowing 12 000 Trade payables 1 350 Deposit from customer 2 000 Advertising payable 600 Interest payable 1 500 17 450 237 500 Capital at start = 30 000 + 25 000 + 3 500 – 950 + 400 = 57 900

6 (d) Transaction Impact on Bank Balance in business records Increase Decrease (i) Nil Nil (ii) - 75 (iii) - 1 720 (iv) Nil Nil (e) Importance of reconciling business bank records with the bank statement ❑ Ensures that the differen